Preparing an income statement for Forgetful Insurance Company
Background
This project provides a set of annual statements for Forgetful Insurance Company. These annual statements are based on statutory accounting principles. The account balances & results for the year are reported in column F. However, the figures reported in column F fail to take into account two transactions described below:
Transactions omitted:
1. On August 1, 2007, Forgetful underwrote a $150,000 one-year policy. Forgetful collected the premium in cash less a 18% commission.
By December 31 2007, $40,000 of losses and $5,000 of loss adjustment expenses were incurred but neither of these expenses were paid.
2.To minimize the company's risk and to gain surplus relief, the company ceded 75% of the policy described in transaction 1 to a reinsurer on August 1, 2007. The reinsurer's commission was 20%. Forgetful received the commission in cash. The reinsurance is a pro rata reinsurance contract.
Hint: Record the ceding reinsurance commission as a reduction in the policy acquisition expenses.
Instructions
I. Adjust Forgetful Insurance Company's 2007 annual statements to reflect transaction 1 and report these adjusted results in column "I". Adjust the annual statements to reflect both transaction 1 and transaction 2 and report these adjusted results in column "K".
II. Compute each of the following ratios using the "unadjusted" data as provided in column "F". For additional practice, recompute the ratios using the data you generate for the other columns.
a. Capacity ratio
b. Liquidity ratio
c. Return on policyholders' surplus
d. Loss ratio
e. Pure loss ratio
f. Combined ratio (financial basis and trade basis)
g. Investment earnings ratio
III. In column "G", prepare a common-size income statement and common-size balance sheet based on the annual statement data provided in column "F".
Other information & data:
1. Assume the insurer is exempt from taxes.
2. Admitted assets at the start of 2007 totaled $1,675,000.
3. Invested assets' fair market value at year-end is $1,500,000.
4. Net premiums written, ignoring transactions 1 and 2 is $600,000.
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Forgetful Insurance Company
Statutory Income Statement
For the year ending Dec. 31, 2007
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Underwriting income:
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SAP
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Common- size forcolumn F
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SAP Adjusted for trans 1
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SAP Adj'd for trans 1 & 2
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Premiums earned
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$
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550,000
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Losses incurred
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-325,000
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Loss adjustment expenses incurred
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-65,000
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Policy acquisition expenses
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-100,000
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Net underwriting gain/loss
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$
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60,000
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Investment income:
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Net investment income
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$
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35,000
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Other income:
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Other income
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$
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5,000
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Income before dividends & income taxes
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100,000
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Dividends to policyholders
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-10,000
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Income before taxes
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90,000
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Income taxes
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0
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Net income
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$
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90,000
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Statement of Changes in Policyholders' Surplus
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Policyholders' surplus, January 1, 2007
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470,000
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Net income
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90,000
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Add: Decrease in non-admitted assets
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10,000
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Capital changes
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0
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Dividends to shareholders
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0
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Changes in surplus for the year
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100,000
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Policyholders' surplus, Dec. 31, 2007
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570,000
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